Crisis interruptus

The euro bond might give the zone a much-needed breather

With the European Union (EU) on the brink, the world is hoping that the political leadership in Germany has an epiphany at the weekend ministers’ meeting in Poland and agrees to plans for a common euro zone sovereign bond that could avert Europe’s “Lehman moment”, and the prospect of fresh financial contagion. Although such a bond cannot address the deeper structural issues that the euro zone faces, of slow growth and political asymmetries, this joint debt issue will go some way towards easing the impending credit crunch by lowering the cost of borrowing for debt-ridden countries and, as important, sending signals to the investor community that Europe’s strong economies are – finally – ready to take some responsibility for the smaller and weaker states. The way European stocks rebounded Wednesday suggested that the markets were hopeful of a workable solution. A joint bond issue is unlikely to avert a Greek default; despite an austerity package, Greece has declared that it will be out of cash by next month and, indeed, credit markets are factoring in a 90 per cent chance of default. But the bond could, at the very least, limit the credit crunch to Europe’s smaller economies like Greece, Ireland and Portugal, all of which have received rescue packages from EU and the International Monetary Fund, and prevent the contagion from spreading to the bigger and more resilient economies like Spain, Italy and even France. With Moody’s mid-week downgrading of two French banks, Societe Generale and Credit Agricole, that threat had become a clear possibility.

The spectre of a second economic meltdown in three years has been real enough for US Treasury Secretary Timothy Geithner to make his second trip to Europe in two weeks – American exposure to French debt is fairly high – and he will attend this weekend’s meeting in Poland. Even Chinese Premier Wen Jiabao has been moved to offer some, albeit opportunistic, help (in return for easier anti-dumping norms). And Brazil and India are considering raising their euro exposure to save Europe. Much, however, depends on German Chancellor Angela Merkel, whose intransigence has played a big role in bringing Europe to the brink. She is, of course, responding to popular opinion in her country that has publicly deplored the need to leverage its own strengths to pick up the tab for the profligacy and economic mismanagement of another country. This in itself reflects the incomplete nature of the monetary union which tied 17 countries to a single currency subject to certain benchmarks that, incidentally, few of them have followed. 

Consider the requirement that sovereign debt be limited to 60 per cent of GDP. If Greece’s debt is 142 per cent of GDP, Germany itself has scarcely been a stickler with 85 per cent. A euro-bond issue will also give Europe the breather it needs to redefine the contours of the monetary union. One sticking point about the euro bond is that it is likely to come with stricter and more intrusive financial oversight, at which member countries may baulk. Thursday’s in-principle agreement between the European Parliament and EU members on what is known as the “six-pack proposal” to tighten deficit controls raises hope for compromise on a sovereign bond. In any case, given the options before EU, the Polish solution might be its last chance at avoiding financial mayhem.